Three ‘Simples’ Principles for Controlling Run-Away Finance?

I have been thinking about what sort of moral principles ought to apply to finance, including banking. The sort of thing I’ve been thinking about are some fairly simple things that would appear obvious to most of us, but apparently don’t apply to the world of finance.

Today I heard a Lib Dem MEP say something to the effect of “what are we going to do, stop the markets from doing certain things”? Well, er, yes. We stop ‘the markets’ from trading in human body parts, or in whole humans for that matter. We don’t allow them to freely trade nuclear weapons, or other WMDs. In other words there are all sorts of moral and practical restrictions placed upon the markets, for our own protection. After the gigantic and still unfolding damage unrestricted financial markets have managed to inflict, isn’t it time to consider what they should not be being allowed to do?

Things like:

You should not be able to sell stuff you don’t own.

The whole basis of ‘short-selling’ is you sell something you don’t own now, in order to drive down the price of the things you don’t own so you can later buy them for less than you just sold the things you don’t own for.

I can’t for the life of me see how this generates any value to anybody except allowing the short-sellers to rip everyone else off. Their ‘bet’ that the price will fall is not based on anything ‘real’, like the value of the item, but simply on their ability to manipulate the market. On the contrary, if the thing being sold is something like a companies shares it is doing a lot of damage. What is it good for?

You shouldn’t be able to insure things you don’t own either.

If I were to insure a camera I didn’t own, but actually belonged to my mate, and then he had it stolen whilst on holiday, I don’t know any insurance company that would pay me. Au contraire, I’d probably get a visit from Sgt Plod asking me why I was trying to rip off the insurance company. As with so much else, this doesn’t seem to apply in the topsy-turvy moral universe of finance capital. Here’s the Wikipedia explanation of Credit Default Swaps, which is pretty fair:

“A credit default swap (CDS) is similar to a traditional insurance policy, in as much as it obliges the seller of the CDS to compensate the buyer in the event of loan default. Generally, the agreement is that in the event of default the buyer of the CDS receives money (usually the face value of the loan), and the seller of the CDS receives the defaulted loan (and with it the right to recover the loan at some later time).

However, there is a significant difference between a traditional insurance policy and a CDS. Anyone can purchase a CDS, even buyers who do not hold the loan instrument and may have no direct “insurable interest” in the loan. The buyer of the CDS makes a series of payments (the CDS “fee” or “spread”) to the seller and, in exchange, receives a payoff if the loan defaults.”

Again, I fail to see any utility in this transaction for the real world the rest of us inhabit and if I tried to pull this stunt with a car I’d end up in prison.

You should pay tax on every transaction that supposedly ‘adds value’.

One of the main reasons for financial systems running amok is the volume of trades – these have spiraled to unprecedented levels. When the rest of us buy and sell things we (mostly) pay VAT on the transaction, which, in case you have forgotten is “value added” tax. So if these financial transaction as ‘value adding’ as their proponents claim, why don’t they have to pay tax on them? When a car component manufacturer sells a car widget to the manufacturer they have to pay a whopping 20% VAT. Why doesn’t this apply to financial ‘products’?

You might argue that some financial transactions are bets are may gain or lose value. True, but we tax betting too and anyway if I sell something at a loss I still have to charge VAT on it and the buyer has to pay it.

This is the essential argument of the ‘Robin Hood’ or ‘Tobin’ tax proponents – in this a case a very small tax leveled on every financial transaction. This would have the doubly beneficial effect of hopefully slowing the trade a bit and generating some much needed tax revenue.

So there you are: three simple principles that seem to me eminently sensible and morally justifiable as restrictions which might prevent the massive destruction of social value we’ve seen over the past 3 years.

As a good social scientist I don’t necessarily believe these are ‘the’ answers – maybe they are wrong or incomplete. Maybe there are special rules for finance that I don’t understand and mean it should not be subject to the same sort of rules as apply to the rest of business and life. I genuinely curious to know why some seem to think this is the case. All comments welcome……

One of the problems with this approach is that things like CDS markets have been instrumental in holding down the costs of insurance for a whole variety of people – from corporate debt through to car insurance policies taken out by people in the “real” (as though the bankers existed in some alternate plane of existence by a quirk of quantum mechanics) economy. The financial markets have, in my experience, generated a huge slew of benefits to the world at large – not only cheaper goods, but also more predictable prices and a far deeper pool of capital that companies, governments and individuals can draw upon.

That said, there clearly needs to be a reform of the system. I think that the best place to start isn’t prohibiting this trade or that instrument – it’s transparency and competition. Markets work better when they are more open and more competitive and the financial services sector has been a potent advocate of free markets in recent years. So let’s free the market – end too big to fail, introduce new accounting standards, lower market share requirements to initiate a competition investigation and break up the nationalised banks into an array of new financial institutions. One of the problems with these instruments was that it was too hard to tell where they were in the financial system – another was that there were too many banks that were simply too big. But rather than starting from the other end – prohibiting this and that, probably triggering a response in the form of new innovations that move the trading elsewhere (either further off exchanges, away from more heavily regulated states or into more complex instruments) government should push the other way.